Income trusts defy the times
Financial Post
RESIDENTIAL EQUITIES: REEun/TSX: July 31: $14.25 -5 cents: Vol: 16,099: (See print copy for complete chart/graph.)
ARC ENERGY TRUST: AETun/TSX: July 31: $12.40 -6 cents: Vol:165,870: (See print copy for complete chart/graph.)
SUPERIOR PROPANE INCOME: SPFun/TSX: July 31: $18.75 +41 cents: Vol 135,269: (See print copy for complete chart/graph.)
There are some islands of relative calm in these rough equity markets and the Canadian income trust sector stands out as one of them, says Oscar Belaiche, portfolio manager, whose responsibilities include the co-management of Dynamic Focus + Diversified Income Trust fund.
"These trusts have, as a group, handily outperformed the Canadian equity market as a whole year to date and will likely continue to do so."
The reason, he says, is that they have a fairly predictable cash flow and make regular, often monthly, distributions to unitholders. "This income support is the ballast."
Dynamic launched its income trust fund in July, 2001. "Income trusts have become an increasingly important asset class in Canada with a market capitalization at recent count of $38-billion," says Belaiche, who joined Dynamic in 1997 with considerable experience as a corporate banker, real estate developer and real estate asset manager. He switched to managing securities when he joined Dynamic.
These income trusts, with their focus on tax-effective income payments, are likely to gain in popularity given Canada's demographics, he says.
As a testimony to their staying power despite the market meltdown, there have been a couple of recent initial public offerings of these trusts which were oversubscribed, says Belaiche.
Dynamic participated in them.
He points to SFK Pulp Fund, which holds a pulp mill in Saint-Félicien, Que. It is being spun out of Abitibi-Consolidated Inc. into a trust. "It is a world class pulp mill."
Another recent issue was Swiss Water Decaffeinated Coffee Income Fund (SWSun/TSX), which recently closed at $10 and trades in a 52-week range of $10.05 and $9.70. This trust has a major slice of the chemical-free decaffeinated coffee market. It sells to companies such as Starbucks and Tim Hortons. This niche in the coffee market is growing as consumers become increasingly health conscious, he says.
Belaiche notes that income trusts as a group were up comfortably until mid-July, but more recently there has been some selling in this sector as investors look to take profits in their winners and raise cash, possibly to meet margin calls on other stocks. These trusts could succumb to further weakness, he cautions. But they do have an edge on more conventional company structures from an investor perspective in that they are generally more conservative when it comes to their balance sheets and executive compensation packages, says Belaiche.
With the spotlight on governance, Belaiche notes that his preference is for trusts that have internal managers, i.e. that are not run by outside companies. The internal management should also have a significant equity stake, aligning its interests directly with those of the unitholders. If there is an external management arrangement, this should be scrutinized, he says.
He is wary, for instance, of agreements between the trusts and the management company that allow for management to share "excessively" in the upside of the cash distributions if the cash flow of the trust exceeds a certain threshold.
It is for this reason that he sold Superior Propane Income Fund (SPFun/TSX) $18.34 ($19.62 - $14.50), which distributes propane and propane consuming appliances. He owned units in this trust for some time. "But it will soon be entering the threshold where external management will be increasing its participation in the distribution to 50%, which is a little too rich from my perspective."
The overall strategy for the fund is to have a weighting in the three classes of income trusts -- oil and gas royalty trusts, real estate investment trusts and trusts of other businesses. "We will overweight or underweight each category depending on market opportunities and valuations."
In choosing trusts for the fund, Belaiche's "ideal" is one that dominates its industry, has internal management whose interests are directly in synch with those of unitholders and the unit should trade at a reasonable valuation.
For the column, he is selecting:
- ARC Energy Trust (AETun/TSX) $12.46 ($13.44 - $10.25), which has a yield of 13%. Based in Calgary, this investment trust provides unitholders with 99% of the royalty income of conventional oil and gas properties. ARC Energy Trust has oil and gas properties in Alberta, Saskatchewan and British Columbia. Currently, natural gas constitutes 45% of its production and oil 55%. Expected distribution per unit is $1.56.
- Davis + Henderson Income Fund (DHFun/TSX) $11.05 ($11.50 - $9.90), which has a yield of 7.3%. Based in Toronto, this company prints and distributes cheques for the Canadian chartered banks. It has a major slice of this business, which it has been in since 1875. Even though the total demand for cheques is declining in this electronic age, the trust is increasing revenue by expanding its products and services, says Belaiche. The trust has recently increased its distribution to unitholders to $1.34 per unit per annum from $1.30.
- Livingston International Income Fund (LIVun/TSX) $10.50 ($11.47 - $9.95). This has a yield of 4.2%. Based in Toronto, this trust, founded in 1945, is Canada's largest customs broker and leveraged to the substantial trade between Canada and the United States. "The cash flow is being generated from supplying services to customers which include Ford Motor Co., Alcan, Kellogg and Hewlett-Packard." In all, it has more than 13,000 customers. The trust's annualized distribution is $1.34.
- Residential Equities Real Estate Investment Trust (REEun/TSX) $14.30 ($15.50 - $12.82). This has a yield of 7.3%. Based in Toronto, this company owns a large portfolio of apartment buildings in key locations close to public transportation in Toronto. The portfolio consists of almost 10,000 residential suites and has a book value of $568-million. It is experiencing increased vacancy rates in higher end properties, but the cash flow has still been growing and the demand for rental apartments will climb as the population in Toronto increases. The trust's distribution is $1.05 per annum. |
